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Imperial Tobacco Group PLC (ITY)

FY07 Preliminary Earnings Call

October 30, 2007, 5:00 AM ET

Executives

Iain Napier - Chairman

Gareth Davis - CEO

Robert Dyrbus - Finance Director

Analysts

David Hayes - Lehman Brothers

Elise Badoy - Goldman Sachs

Jonathan Leinster - UBS

Erik Bloomquist - JP Morgan

Adam Spielman - Citigroup

Jonathan Fell - Deutsche Bank

Presentation

Iain Napier - Chairman

Well, good morning, ladies and gentlemen. To those of you here in the room and everyone watching via our webcast, welcome to our 2007 preliminary results presentation. These are the first preliminary results following my appointment as Chairman in January of this year, and I am delighted to be here today. I am joined by Gareth Davis, our Chief Executive, Bob Dyrbus our Finance Director and several other key Imperial executives here in the front row.

Before I start the presentation, I would like to pay a tribute to my predecessor Derek Bonham, who sadly passed away last month. As has often been said before, Derek was the founder of the modern Imperial Tobacco. During his 10 years as Chairman, Imperial transformed from a mainly U.K. based company into what is today the world's fourth largest international tobacco company. Derek was an inspirational leader and a great Chairman, and we will always remember the immense contribution he made to the success of our Company.

Turning now to our results. And I am pleased to report that in 2007 Imperial delivered another record performance. Our cigarette volumes increased by 7% including a six month contribution from Commonwealth Brands and we achieved market share gains in all of our regions. Net revenues rose by 4% to just under £3.3 billion, and adjusted profit for operations was up by 9% to almost £1.5 billion. This translates into a 12% increase in adjusted earnings per share up to 136.7 pence. As a result, I am pleased to announce a proposed final dividend of 48.5 pence, bringing the full year dividend to 62.5 pence, a 12% increase on 2006.

Our success is built on the consistent execution of our strategy, which is to grow our business, both organically and through acquisitions. Excluding the six month contribution from Commonwealth Brands, our cigarette volumes grew by 3% on an organic basis, building on the positive growth momentum we have seen in the last two years. This reflects ongoing investment and strengthening our position in existing markets, plus developing our presence in new markets which offer us growth opportunities such as the US, Canada and Mexico.

Our focus on sales and marketing excellence drives our top-line growth, leveraging our wide product portfolio which includes international strength in cigarettes and world leadership in fine cut tobacco, papers and tubes. This is underpinned by ensuring that our manufacturing base remains flexible and responsive to changing market dynamics and of course we maintain a relentless focus on effectively managing our cost base.

The other element of our growth strategy is acquisitions, through which we have created significant value for our shareholders over many years. Following the acquisition of the worldwide Davidoff cigarette trademark in September 2006, we have accelerated the brand’s development and geographic profile growing its volumes by 5% and increasing its profit contribution by 13% during the year.

In April, we completed the acquisition of Commonwealth Brands, the fourth largest cigarette company in the US. We are extremely pleased with its early performance with returns in investments in the first six months exceeding our weighted average cost of capital.

And of course we are currently in the process of acquiring Altadis, and Gareth will updater you on some more details later in the presentation.

So all in all, this has been an excellent year, one that I believe is typical of Imperial’s long track record of creating shareholder value, and one that we are going to continue to build on, going forward.

Thank you, ladies and gentleman. I'll now hand over to Bob who will take you through the financial details.

Robert Dyrbus - Finance Director

Thanks, Iain. And, good morning, ladies and gentlemen. 2007 has been a strong of both organic and acquisition net growth. Net revenue rose 4%, despite a significant negative impact from the cessation of Singles in Germany and foreign exchange.

In cigarette terms, our volume growth of 7% translated into an 8% increase in net revenue. Adjusted profit from operations is up by 9%. And our group adjusted operated margin increased by an impressive 210 basis points to 45%. Adjusted profit before tax grew by 6% with net interest ahead of last year primarily as a result of Davidoff and Commonwealth acquisitions, and after tax charge, the reduced effective rate of 25% and minority interests. Adjusted earnings per share grew by 12% with the proposed dividend up 12% to 69.5 pence a share.

Our first half results were adversely affected by an estimated £16 million due to negative impact of the weak euro and U.S. dollar against sterling. In our second half, the strength of sterling against both currencies continued compared to the same period last year. This resulted in an estimated exchange loss in the year of £49 million at the net revenue level and £25 million at the profit from operations level. There was a compensating benefit of £2 million pounds to our interest charge.

These exchange movements reduced our adjusted earnings per share by 2.5 pence such that our EPS growth would have been 14% rather than 12% reported.

Before I go into the regional results, there have been a couple of changes to our reporting segments. With effect from the 1st of October 2006, we've reclassified the results of our Austrian business from Germany to the Rest of the World. The results from 2006 have been restated accordingly, and following the Commonwealth acquisition we decided to introduce a new reporting segment for the United States. We've adjusted the 2006 numbers so that the results of our U.S. papers and tubes business are included in this region as comparators.

So, looking at the summary of the regional results. In the U.K., net revenue was up 5% to £876 million, with adjusted profit from operations at 11% to £564 million. Our cigarette share grew further, and our profitability improved with the benefits of the manufacturers' price increase and reduced costs.

In Germany, 2007 was a year of transition, with net revenue declining to £524 million and adjusted profit from operations down at £238 million. In a challenging year, our results benefited from continued growth in our cigarette share and cost savings, but were adversely affected by the migration of the £20 billion stake equivalent singles market in 2006 to alternative products.

In the rest of Western Europe, both net revenue and adjusted profit from operations were stable at £635 million and £326 million respectively. We continue to grow cigarette share in most of the markets in the region where the pricing environment has improved significantly over the past 12 months. Our profits were impacted by lower travel retail volumes, which had a compensating benefit to our U.K. performance, as well as a foreign exchange impact of £5 million.

In the U.S., the six month contribution from Commonwealth was very much in line with our expectations, benefiting from our manufacturers' price increase. Our U.S. operations as a whole delivered net revenue of a £117 million, adjusted profits from operations of £52 million, and an operating margin of 44.4%.

And finally, for the rest of the world, net revenue was up 2%, and adjusted profit from operations grew 17% to £185 million, in spite of a £17 million foreign exchange impact. And there was a sharp increase in the operating margin, up to 26.2% this year. This excellent performance was driven by increased cigarette volume and share gains in almost all of our key markets, with the improved pricing environment, particularly in Central and Eastern Europe.

Turning now to our cash generation. Comparing the cash flow operating activities after net CapEx, but before interest and tax, to our adjusted profit from operations, we show conversion rate of 81%. This is lower than normal due to a higher level of net capital expenditures, as well as the short term increase in working capital of a £194 million, primarily as a result of stock building in certain central European markets in advance of duty increases due in January 2000 late.

Cash outflows include gross capital expenditure of a £133 million, up on 2006 as a result of increased manufacturing investment, primarily, in our new factory in Taiwan, and machinery in our plants in Germany and Eastern Europe. Proceeds from the sale of fixed assets during the year of £95 million with negligible profit impact. And our tax payments were broadly in line with the related charge.

On the acquisition front we bought Commonwealth Brands for a £1 billion, and at the time of announcing the deal on the 8th of February we said that we were suspending our buyback program from that date. And with the proposed Altadis deal and the subsequent rights issue, you can be sure it's not going to be resumed immediately.

Our closing adjusted net debt rose to £4.8 billion in September 2007, largely as a result of the Commonwealth acquisition with share buybacks at the beginning of the financial year and dividends offset by free cash flow throughout the year. Our average net debt level for the year rose to £4.3 billion, predominantly due to the Davidoff cigarette trademark and Commonwealth acquisitions.

The all in average cost of debt for the year rose marginally to 5.5% from 5.4%, as a result of increases in underlying interest rates. Our interest charge rose from a £188 million to £237 million, reflecting the increase in our average level of debt to £4.3 billion and the rising cost of debt.

Under IFRS, net finance costs includes two items relating to pensions and derivatives, which this year amounted to a net benefit of £56 million and we exclude these items from our adjusted EPS. And our adjusted interest cover declined to 6.2 times.

In summary, we have delivered another record set of results reflecting good in-market performances combined with the benefits from acquisitions. We generate further earnings growth from the effective management of our cash, whether it be an organic investment projects, value creating acquisitions or share buybacks. And over the past five years, adjusted profit from operations has grown 13% a year on a compound basis whilst adjusted earnings per share and dividend per share, have grown by 15% and 16% respectively. And going forward, we are confident in our ability to continue to create long-term sustainable value for our shareholders.

So thank you, ladies and gentlemen. I'll now hand you over to Gareth to go through our operational performance.

Gareth Davis - Chief Executive Officer

Thanks, Bob, and good morning, ladies and gentlemen. It’s very nice to see you all here today. It’s also nice for Bob and I to have a rare day out in the capital away from our smoking shelter in Bristol.

I would like to start with a brief overview of where we are with the Altadis acquisition. As you know, we received European Commission approval on the 18th of October, subject to the enlarged group divesting a small number of fine cut and pipe tobacco and cigar brands in certain European markets. We anticipated some divestments and as we said at the time, they will not materially affect the operational and financial performance of the enlarged group. We expect CNMV approval soon. This has taken longer than we originally anticipated due to the change in the Spanish takeover laws in August, and the fact that this is the first major deal to be assessed under these new rules. The offer acceptance period begins after we receive CNMV approval, during which time Altadis will hold its own EGM. Given the Christmas and New Year holidays, we now expect to complete the deal in January 2008. We have committed funding in place which has not been affected by recent market events, and the rights issue will occur before the 18th of July, 2008.

We are very much looking forward to completion and realizing the considerable opportunities that the deal presents, and we'll keep you updated on progress.

Also I’d like to briefly look at regulation and litigation, now, rather than cover them off as I go through each of the regions, and I’ll start with the World Health Organization's Framework Convention on Tobacco Control, which held its second Conference of Parties in July. At the conference, a draft guideline on environmental tobacco smoke was adopted, and it was also agreed to conduct further work on guidelines relating to product regulation, advertising and sponsorship, and illicit trade.

In a number of markets in which we operate the debate on pictorial health warnings has continued. These warnings are now a requirement on all cigarette packs sold in Belgium, and from October 2008, they will also be required on all U.K. tobacco products. Pictorials will also start appearing on cigarette packs in New Zealand next year, with Taiwan expected to follow suit in 2009.

During the year, we also saw further restrictions on smoking in public places in France and Germany. And, of course, in the U.K. there is now a comprehensive ban, following the introduction of restrictions in Wales, Northern Ireland and England.

We’ve previously mentioned the Office of Fair Trading’s inquiry into certain aspects of the UK tobacco supply chain, which began in mid 2003, and is still ongoing. Imperial and a number of other companies have supplied information as part of this inquiry, and we continue to co-operate with the OFT.

In the US, legislation proposing an increase in federal excise tax on tobacco products has been unsuccessful. But the debate is ongoing, and there are also discussions continuing about whether the Food and Drug Administration should be given the authority to regulate tobacco.

The litigation landscape continues to improve, particularly in the US, where the vast majority of individual and class action claims have been decided in favor of the tobacco companies. We were pleased to see a case against Commonwealth Brands dismissed with no right of appeal in June 2007. And of the two remaining individual claims against Commonwealth, one has been dismissed, although could still theoretically be appealed, while the other is inactive and has been for some time.

So I hope that brief overview was helpful. Our operating environment is challenging but we have successfully developed our business in this climate for many years, and I’m confident that we'll continue to do so in the future.

Now, moving on, and as Iain said, we have produced another record set of results in 2007. We’ve benefited from six month’s contribution from Commonwealth Brands and have seen our overall cigarette volumes increase by 7%, with market share gains in all our regions. On an organic basis we have grown cigarette volumes by 3%, with particularly strong gains in Central and Eastern Europe and Asia. This has been driven by some excellent performances from our key strategic brands, Davidoff, West and JPS, supported by continued good progress from a number of our strong regional brands.

And in manufacturing, we have again delivered excellent productivity gains and cost progress, and as you heard earlier, our profitability continues to improve, with our group operating margin up from 42.9% to 45%.

Before reviewing our operating regions, I’d like to take a quick look at some of our cigarette brand highlights. Davidoff increased volumes by 5% to 14.5 billion sticks, driven by growth in Eastern Europe and the Middle East. If we exclude Taiwan, which was impacted by down-trading and increased competition, underlying Davidoff volumes grew by an impressive 14%. As Iain said, we have accelerated the development of this key brand, widening its availability and investing in successful and innovative new variants such as Davidoff Slimline and Davidoff Rich Blue.

West also grew volumes, up by 9% to 27 billion, with particularly good performances in Western and Eastern Europe and Taiwan. Outside its core market of Germany, volumes of West were up 20%. As with Davidoff, we continue to be active with West, increasing its international presence by launching it into a number of new markets during the year.

JPS was a tremendous success story in 2006, and I’m pleased to report it has had another terrific year, growing volumes by 18% to 13.5 billion, reflecting excellent gains in a number of markets, particularly in Germany, The Netherlands and Austria.

Now these are great performances, continuing the trend of the last three years. If you combine the volumes of these three key brands, and compare the totals for 2007 and 2004, the increase is an impressive 36% or a compound annual growth rate of 11%. And going forward, these brands will continue to benefit from further investment.

Moving onto our regional tour now, and we’ll start with the U.K. We estimate that the UK duty paid cigarette market has declined by 2%, down to 47.9 billion sticks for the year. After a buoyant first half, the market resumed a more normal underlying rate of decline, with a dip towards the end of the year following the introduction of public place smoking bans in Wales, Northern Ireland and England. The impact of these bans has been pretty much as we anticipated, although in England, the initial dip has been a little larger than expected due to the bad summer weather. However, by the end of September we estimate the impact in England was around 4% and we expect this to diminish further over time, reflecting the trends we have seen in other markets with similar legislation.

Cigarette down-trading in the U.K. has continued, with the premium sector falling from 29% to 27% of the market as a whole, whilst the value and economy sectors have grown from 42% to 44%. There has also been down-trading into fine cut tobacco with market volumes up 8% to around 3,500 tons.

Performance wise, it was another tremendous year for our U.K. business. We grew our cigarette market share from 45.5% to 46.4%, with Lambert & Butler, the U.K.’s best-selling cigarette brand, climbing to 16.6%. Richmond, the UK’s number two brand, was up to 15.7% share, while the Windsor Blue success story continues. It is now the U.K.’s fastest growing cigarette brand, capturing a 2.6% market share since its national launch in January 2006.

Our fine cut tobacco share slipped to 63.6% but Golden Virginia continues to lead the market with 47.6%, supported by Drum at 15.5%. And in June we launched Gold Leaf in the growing value segment and we are very encouraged by the early results, with the brand achieving a spot share of 1.6% in September.

Rizla, the world’s leading rolling paper brand, grew global volumes by 4% and remains the market leader in the U.K., and we are looking to add to its success with the recent launch of a new variant, Rizla Smooth.

In terms of outlook, once the initial impact of public place smoking bans has dissipated, we expect annual cigarette market declines of 3% to 4% in the UK, in line with the long term trend. With our strength in value cigarette brands we will continue to benefit from the down-trading dynamic, and by strengthening our portfolio with the launch of Gold Leaf, we are also well positioned to capitalize

on down-trading in fine cut tobacco. The U.K. is an important profit centre for the Group and with our broad product and brand portfolios we are well placed to build on our market leading positions.

So let's move on now to Germany. And this has been a challenging environment this year. We estimate that the total German duty paid market declined by 6% to 127 billion cigarette equivalents during the year. This follows a period of successive tobacco tax rises and the cessation of Singles last year, which have increased legal and illegal cross-border flows. We estimate that around 22% of cigarettes consumed in Germany are non-German duty paid, compared to around 7% in 2003. Although, there are signs that the rate of increase in cross-border flows is at least slowing.

In terms of the duty paid cigarette market, we estimate volumes have declined by 1% in the year to 91 billion sticks. The low price cigarette sector has seen further growth as a result of down trading and Singles migration, and it now accounts for more than 19% of the cigarette market.

In contrast, Private Label’s cigarette share continues to decline, down to 12.5% from 13.4% during the year. In other tobacco products there was a 16% decline in market volumes, from 43 billion stick equivalents in 2006, around half of which were Singles, to 36 billion in 2007. We estimate that 20% of former Singles consumers have moved into duty paid cigarettes, 55% into other tobacco products, and 25% into both legal and illegal cross-border flows.

The market remains extremely competitive, illustrated by the fact that since Singles ceased to be manufactured around 18 months ago, more than 200 new cigarettes and OTP stock keeping units have been introduced onto the market by manufacturers. Against this background, we have grown our cigarette share to 21.3%, with another strong performance from JPS, which climbed to 6.4% of the market during the year, and with a spot share in September of 7.2%.

West is the second largest cigarette brand in Germany, and along with other mid priced brands, continues to be impacted by down-trading, with its share now at 7.2%.

At the premium end, Davidoff remained broadly stable at around 1%.

Our market share of other tobacco products declined to 19.1%, impacted by Singles migration and increased competition, particularly in traditional roll-your-own products. However, our make-your-own products performed well, with West and JPS Single Tobacco and newly launched Route 66, capturing a 37% share of this growing segment.

Despite the challenges in Germany, we are optimistic about the future. The market disruption caused by the end of Singles and the subsequent consumer migration is now largely over, and the increase in cross-border flows appears to be slowing.

We will seek to build on our positive cigarette progress, and with our broad product portfolio, we remain well-positioned to benefit from the ongoing down-trading within cigarette, and from cigarette into OTP. Coupled with our experience in cost management, this will ensure that we remain competitive and focused on delivering profitable growth.

Moving onto the Rest of Western Europe, where we have an expanding cigarette footprint, and where we see further growth opportunities for Imperial. We estimate that the regional cigarette market was stable at 320 billion sticks. Pricing has improved, with increases in a number of markets, including Spain, the Netherlands and France. The fine cut tobacco market was up 2% to around 31,000 tons, with the market remaining extremely competitive due to a number of low price product launches and extensions of cigarette brands.

In our Western Europe travel retail business, we sell our brands to traveling consumers, mainly from the U.K. Volumes have again declined this year, further impacted by changing purchasing patterns and prices. And this has affected our overall cigarette volumes in the region, particularly in Spain.

Building on our success of last year, we again grew our market shares across the region. In Ireland, our cigarette share increased to 26.4%, with a strong performance from John Player Blue. We strengthened our portfolio in Belgium with the launch of JPS, which together with another good performance from Bastos and Route 66, grew our share to 10.6%.

Our cigarette market share grew to 10.6% also in the Netherlands, with an excellent performance from JPS. Davidoff and West both had another good year here in Greece, driving our overall share up to 9.7%. And in November we strengthened our portfolio with the launch of Drum cigarettes, which now have a 0.5% share.

In Spain, our market share was impacted by lower travel retail sales with the increase in prices, not only impacting volumes of our Brit brands but also those of JPS. However, West performed exceptionally well and volumes more than doubled. Our shares increased in France and Portugal due to good growth from JPS.

Overall, the key brands in the region performed strongly with volumes of West up 27% and Davidoff up 8%. Whilst JPS volumes were down 8% overall, if Spain is excluded, regional volumes were up 19% year-on-year.

As I said earlier, the fine cut tobacco market remains very competitive. Although our volumes were fractionally down, we continue to lead the regional market and there are indications that our portfolio extensions and repositioning initiatives are beginning to bear fruit. Bastos has grown our share in Belgium to 10.9%. And although our share was down in France, we saw good growth from JPS.

The Netherlands is the largest fine cut tobacco market in the region. Here, our share was stable at 51.1% with Zilver and Evergreen performing well, and our September spot share was up to 51.6%. And in Italy, the launch of Peter Stuyvesant make-your-own in April has been a great success, capturing

2.9% of the fine cut tobacco market by September.

In summary, this remains a competitive region with a challenging regulatory climate, but we believe the strength and breadth of our portfolio offers us a number of growth opportunities.

Our cigarette shares continue to grow, and with improved pricing, particularly in key markets like Spain and France, we are optimistic about the future. And although the fine cut tobacco market will remain challenging, the steps we have taken to improve our position are paying off, and we are focused on maintaining this momentum, going forward.

As Bob said, we have a new reporting segment, the US, a market that offers great potential for Imperial. The US is the world’s second largest cigarette market by volume after China, and accounts for around 20% of the tobacco industry’s global profits. In 2007, we estimate the overall US cigarette market declined by 3% to around 367 billion sticks, with the discount sector accounting for 27% of the total cigarette market.

The other tobacco products sector is dominated by smokeless tobacco, which accounts for around 60% of OTP volumes. Cigars and cigarillos account for about 30%, with fine cut tobacco and pipe tobacco making up the remaining 10%.

We believe fine cut tobacco has tremendous potential in the US. In 2007, we estimate volumes increased by 10% to 10,000 tons and we are well placed to capitalize on this growth trend given our world leadership in this segment.

The acquisition of Commonwealth Brands has given us a strong presence in the US. Cigarette volumes were 7.1 billion, with our cigarette share at 3.7% of the total market, and 13.4% of the discount sector, where our portfolio is positioned. Our two key brands, USA Gold and Sonoma, are the third and sixth best selling brands in this sector, with respective sector shares of 8.2% and 4.8%.

In July we acquired the US trademarks of Bali Shag and McClintock fine cut tobaccos from Peter Stokkebye in Denmark. Prior to this, Commonwealth was the exclusive distributor of these two brands which had a combined share of around 1% of the fine cut tobacco market. And of course, we have our existing papers and tubes business, which has had a good year, growing volumes by 13% and 8% respectively.

In terms of our Master Settlement Agreement application, we continue to enjoy very constructive dialogue with the National Association of Attorneys General, and representatives from several settling states, and we expect to complete our application in a few weeks.

We have high expectations for our US business. We have finalized plans for the launch of Imperial’s brands and are in a position to begin their rollout once we have completed all aspects of becoming a participating manufacturer in the MSA. We continue to monitor the ongoing debates regarding tax and regulation and we're confident of being able to manage the impact of any changes. Given the strength and versatility of our multi-product portfolio, and the enhanced platform from which we will be launching our own brands and products, we are very confident of being able to accelerate our growth in the US.

The final stop on our tour is our Rest of the World region where we continue to see considerable opportunities for long term sustainable growth. This region offers numerous opportunities to expand our business and grow our brands and profits.

Our cigarette volumes in the region grew by 6% and we improved our market share in virtually every market in which we operate. In Asia, our cigarette volumes grew by 4%. Our market share rose to 11.7% in Taiwan. Davidoff volumes were impacted by duty increases but this was more than offset by an excellent performance from West, which has grown its share from 0.3% to 1.7% during the year.

In Vietnam, the total cigarette market declined due to tax driven price increases. But our market share was up slightly at 10.6% with further growth in Bastos. In Laos we delivered volume growth of 22%, with another good performance from the A brand family. And in China, our volumes of Davidoff and West have increased following distribution into several additional cities, along with positive developments in Hong Kong and Macau.

In the highly regulated mature markets of Australia and New Zealand, we improved profits, but our market share was down slightly in Australia to 17.5%, and broadly stable in New Zealand, also at 17.5%. In Africa, we’ve made good share gains in almost every market with our own brand volumes growing by

7%. However, overall volumes were affected by the termination of manufacturing agreements with third parties. Our best performing brands were Superkings, Good Look and Mustang, all with double digit volume growth.

In the Middle East, Davidoff continued to perform well, growing its volumes by 29% and driving share gains in most markets in the region, including Saudi Arabia where our share rose to 7%.

Now let’s look at Central Europe, where we have improved our profitability, grown volumes by 11% and made cigarette share gains in most markets. Our leading growth brands in this region are Moon, Golden Gate and JPS. In Austria, we now have our own sales force and this has helped accelerate our market share growth to 7.8%, with a particularly strong performance from JPS. The majority of the other markets in this region are EU accession countries, where taxes are rapidly increasing as they work towards reaching the EU minimum tax levels by the end of their derogation periods. In this environment, fine cut tobacco has grown dramatically, with our regional volumes doubling during the year.

Looking at some of the individual performances. In the Czech Republic, Moon increased our market share to 12.2%. We’ve made great progress with Golden Gate in Hungary and Slovakia, where its brand share grew to 5.2% and 24.1% respectively. In Poland, the largest market in the region, the profitability of our premium and mid-priced brands was improved by a manufacturer’s price increase, and our market share climbed to nearly 17%.

Elsewhere, in Scandinavia, we have focused on developing our snus position, increasing our volumes by 46%. In Norway we have grown our snus share to 9% and also improved our cigarette share to 3.5%, driven by growth in Davidoff, Paramount and West.

In Eastern Europe, alongside our established positions in Ukraine and Russia, we have growing operations in Turkey and the Caucasus. Our cigarette volumes continued to grow, up by 8% in the year. Our Russian market share was stable at 5.5%, whilst in Ukraine, Classic continued its upward trend, helping to increase our market share to 20.6%. We had good performance in Turkey, with our volumes up 85% and our market share improving to 2.5%, with strong growth from West, Klasik and Davidoff. And in the Caucasus, we saw significant volume increases with good performances from West, Davidoff and R1.

Our Rest of the World region continues to expand, and this year we entered the Canadian cigarette market with Davidoff and we launched both Davidoff and West in Mexico.

In duty free, our cigarette volumes were stable, whilst our fine cut tobacco volumes grew by 27%, driven by sales in the Middle East and the Caribbean. Davidoff was the star performer in duty free, particularly in the Middle East, the US and Asia, following the introduction of new variants.

The Rest of the World is a key area of future investment and potential growth for the group. And going forward, we’ll be focused on building our presence in existing markets, whilst continuing to look for opportunities in new markets. Given the size and diversity of this region, we believe there is considerable scope for continuing development. We remain focused on supporting our brand development and route to market, whilst seeking investment opportunities that will enhance our geographic profile and further drive our impressive margin development.

And finally to manufacturing, where once again, David Cresswell and his team have delivered another excellent performance. Now you will know from our September trading update that David will be retiring at the end of the year after a mere 46 years with Imperial, and I’d like to take this opportunity to thank him for the huge contribution he has made to the Company. David has been instrumental in building our world leading reputation for managing low cost, high quality operations. It’s been a pleasure to work with him, and we all wish him a long and happy retirement. Thank you, David.

His successor is Gary Aldridge, Regional Operations Director for Central and Eastern Europe, the Far East and Africa. Gary has a strong track record in the tobacco industry, having held a number of senior manufacturing roles in RJ Reynolds before joining REEMTSMA in 2001. He will sit on the Chief Executive’s Committee and is here with us today. Gary, we wish you every success when you take over as Manufacturing Director in January.

In 2007, our overall productivity was up by 7%. Cigarette and fine cut tobacco unit costs were down 3% and 13% respectively, and we further reduced the number of blends by 10%. As Bob said, our investment in manufacturing has increased this year, with the construction of our new cigarette factory in Taiwan, now underway, and due to be completed by the end of our 2008 financial year. Other initiatives included new or upgraded machinery in Germany for the production of Superslims, and in Russia and Ukraine in order to increase capacity and meet growing demand.

During the year, we also completed the closures of our factories in Liverpool and Lahr in Germany. In total, we achieved manufacturing savings of £33 million in 2007 from a number of different areas, including productivity gains, unit cost reductions and restructuring benefits.

In conclusion, 2007 has been another successful year for Imperial, adding to our excellent track record. We’ve maintained our positive momentum with further organic growth and robust brand performances. Our strong cigarette performance is complemented by our world leadership in fine cut tobacco, papers and tubes. Our expanding geographic base, and the versatility of our product and brand portfolios means we are well positioned to deliver long-term sustainable growth in new and existing markets.

In the US, the completion of our MSA application will open up considerable growth potential for Imperial and we are very excited about the opportunities that lie ahead.

And of course, there is the Altadis acquisition, which we expect to complete in January. Altadis is a great strategic fit with Imperial and will strengthen our position as the world’s fourth largest international tobacco company. It provides us with significant enhancements to our operating platform and scale, with an increased presence in profitable mature markets as well as improved opportunities in emerging markets. And we will also benefit from a stronger and more diversified brand and product portfolio. We aim to rapidly integrate the two businesses and expect to generate revenue benefits and substantial cost savings from the enlarged group.

We will continue to focus on the successful execution of our strategy, investing in top-line growth, focusing on holding or reducing costs and effectively managing our cash. That stood us in good stead for many years, and I’m confident that it will continue to deliver value for our shareholders in the future.

Thank you ladies and gentlemen. That concludes the presentation. We will now take any questions you might have. The presentation is being recorded, so I would be grateful if you would wait for a microphone before speaking and then give your name and organization. Thank you.

Question and Answer

Unidentified Analyst

In the run up to Altadis during that process, I think you were quite clear that you felt that the scope of revenue synergies in Europe was not being fully appreciated. Now I presume that a significant part of that scope of revenue in synergies referred to pricing rather than the establishment of more pan European brands. Now, do you think there is significant potential going forward, once you take over Altadis to establish more pan European brands? And do you think we are likely to see a significant or any swapping of brands between manufacturers, now that you are effectively down to four large companies? Because we still have quite an element of by country ownership still outstanding.

Gareth Davis - Chief Executive Officer

Yes. I think to the first question. I think, I think we see along two dimensions. We do see, as I said earlier on, we have seen in 2007 and I think we can look forward in 2008, to a better pricing environment in the mature markets of Western Europe. So, I think that’s one of the upsides we see.

The other one in terms of the brands, I think we've demonstrated that without the key brands we are doing pretty well, Davidoff, West and JPS in Western Europe. I think it’s also fair to say we see significant potential, further potential for Gauloises and Fortuna in those markets. Emerging markets quite separately we see other opportunities there, but I am concentrating on these mature ones at the moment. So, I do think there is revenue benefits, not just from pricing, but also from a better exploitation. I think our track record shows that we can grow the share now of key brands. So, I think we are confident that we can do that.

In terms of swapping brands, going forward, I wouldn’t see so much of swapping brands, but I do see downstream probably in the sort of five, six year horizon, a situation of more, what I would contract manufacturing using each other's geographic relative advantage, in terms of manufacturing. So I do see more of that perhaps taking place than has been hitherto. There has always been an element of that and it ebbs and it flows, but I think once you get down to the core group of four major international tobacco companies, the propensity to leverage it off each other's relative advantage is probably greater.

Iain Napier - Chairman

I think the only other point to make is in terms of the Altadis acquisition when we were taking about synergies, we were talking there about cost synergies. We said that there could be revenue synergies but those weren’t taken into the number that we quoted.

Gareth Davis - Chief Executive Officer

Okay, another one down there.

David Hayes – Lehman Brothers

Hi, it's David Hayes from Lehman Brothers. Just two questions if I can. Just firstly on Commonwealth, obviously you are waiting for the MSA agreement to come through. But if I went to that business in March and I went to that business today, can you kind of outline things that maybe have changed over that five month period.

Gareth Davis - Chief Executive Officer

Yes, because it's only been a few weeks since I was there. And I had a very nice time, but I think I can remember at least some of it. I think a number of changes. I think, firstly the integration of Robert Burn Associates which was our existing U.S. business that we were, that was going to be the vehicle for our organic growth there, that has been fully integrated now into Commonwealth. So the sales and marketing operation is headquartered in Kentucky and executives have moved, reps have been absorbed into the sales force, so we got now an overall stronger sales force. So all that has been done.

The factory I think is very well bedded down anyway but I think fair to say, Imperial expertise is going to the bolts of that factory, prepared to invest in it. We are already starting to see some element, early days yet, but the run rates starting of cost reductions in that factory, so that’s been a positive. The overall markets in the US declined about 3.5% last year. Commonwealth declined slower than that obviously which was good for the brands. Another brand was launched called Tuscany, which in fairness was on the stocks before our acquisition. And of course they have been hugely helpful in our MSA preparation for the Imperial, not the Commonwealth registration. So we are now in a position of advanced readiness ready to roll out our brands, as soon as the MSA application is successfully concluded. And we expect that in the very near future. So overall it's been a very busy six months for the Commonwealth people. I think we are extremely impressed by the bench strength of talent that they have gotten. And I think we can only see upside going forward.

David Hayes – Lehman Brothers

Okay. And just second question, just on the stock build in Central Eastern Europe. It seems quite early to start building up ahead of January and September, obviously into August September potentially. Can you just talk about, if that’s the norm or whether there's anything special driving that particularly into how that plays out. Thanks.

Gareth Davis - Chief Executive Officer

I am afraid, it has become… I mean, the bad news is, I am afraid, it has become the norm, in those Central European accession countries. The good news is, as soon as they end their derogation, then that’s likely to stop. We were hopeful that it would stop this year but there was a last change of mind or ranks were broken, whatever it is, but something changed. And the fact that stock loading, stock building has started again, in readiness for those January tax changes.

So it does have this effect on our cash flow for a couple of months that unwinds in due course. But it is unfortunate, unnecessary and hopefully the sooner it comes to an end, the better for us and indeed for all manufacturers and I believe the trade. So I look to forward to it ending, but I am afraid it’s here for this year still.

Iain Napier - Chairman

To pick up a point of why September, that seems to be way, way ahead. You have seen that actually now for almost two years we have been growing volumes. I mean part of the thing in terms of investments just to, for an example, investment in Central and the Eastern Europe, is trying to get it from working seven days a week to 24/7 to working five days a week. Well, having put that investment in, we are now looking at another phase, because we are still working 24/7 and it comes down to the ability, just the amount of headroom you have in terms of your manufacturing footprint. There would be no way that we could produce the amount of stock required for example in the four weeks leading up to January. So we are just having to phase it in, when we have got room in our production schedules, frankly.

Gareth Davis - Chief Executive Officer

Okay, a little jump, and there are a couple in the middle, sorry. Ladies first.

Elise Badoy - Goldman Sachs

Elise Badoy from Goldman Sachs. Two questions. The first one, I don’t if there is any even minor costs associated with the changing timetable for Altadis, in particular, on your bridge loan. I don’t know if there is anything associated with that, any option on that?

And secondly, on the day [ph] you came out, you have had a fabulous margin progression this year, again actually because it is a couple of… it is actually a few years really. So what should we expect from there because of course a lot of the margin progression should come from the other but 64% I mean, can you do much, much better than that?

Gareth Davis - Chief Executive Officer

I feel compelled to let Bob answer that. Over the years he’s said it's about as good as it gets. So I will give him that hospital pass now. And I think also you can cover the cost, if any cost of delay in the Altadis.

Robert Dyrbus - Finance Director

Surely. I will tell you what, shall I take the UK margin first? The reality is, our business model which effectively U.K., we said, we see a gradual volume decline as we do see pricing opportunities. So if you like, we will get topline revenue and we are gaining shares. So we get topline revenue growth, the business model holds off, reduces unit costs. So let’s say we hold costs. So that says, maths means, the margin will improve slightly. So I'll conceded that now, but it can get a little bit better because the business model after ten years of trying still holds good. So I will relax my, 'it's as good as it gets' to 'they will ease up slightly.' That’s the first one, that’s a good one, isn't it.

In terms of the cost, there are minor costs involved in terms of the Altadis acquisition. One of the things is, of course, in terms of the equity content while we launched the bid back in July, on the day we went back into the CNMV, we had to put up walls [ph] in place, so we are paying effectively margins on those costs but those will be, a large chuck of those will be rolled up into the acquisition costs. So they are minor in terms of the total deal. And obviously in terms of the bank facility, those we've actually, the loans we have drawn and the ones we have syndicated, again, we had upfront cost but those will be amortized when the loans will be actually drawn down.

I suppose in total we have probably… there's been, I don’t know maybe £20 million or £30 million of embedded cost so far. But that’s not all going to be revenue costs. Some of it will be taken over the life of the loan, when loans are drawn down. Effectively, it's the accounting treatment that’s required under the IFRS. You have to take some of the costs out and just amortize them over the lengths of the loan, be that three or five years, I'd say, go forward.

Gareth Davis - Chief Executive Officer

I think the only point, I would add to Bob’s point on margin is that I think it’s not only the U.K. but I think the overall company margin, we're very pleased with this year. I mean, we have seen positive movements just about everywhere. And the rest of Western Europe some strong margin growth coming up now, not at U.K. levels but very positive momentum. The U.S., a debut margin of you know 44.5% was very pleasing. And I think what was particularly pleasing was a very significant jump in our Rest of the World margin. So, and we've still got more to go for. So I think on the margin front, we are very pleased, because that sort of tells us that our model works, as it were. Jonathan, please.

Jonathan Leinster - UBS

Jon Leinster, UBS. Couple of things. First of all, with America excluding Commonwealth, when you when you acquired it, you said that you would get to an organic EBITDA of around £50 million by sort of 2009. Given the slight delay in the signing of the MSA and given where the dollar's gone, does that sort of still hold true?

Gareth Davis - Chief Executive Officer

Pretty much. I mean it’s not the… in fairness what we said at the time, the MSA could take up to 12 months. I think as we sit here today, we're 13 months since the application. So we're look at a month slippage from the outer regions of our plan. But bear in mind as well the Christmas, New Year period is not a good time to be launching, we want to be well before Christmas or not bother. So if we go into sort of January-February time, we are not going to have lost that much time; a little bit, but not material I'd have to say.

Jonathan Leinster - UBS

Particularly, just following up though, therefore you sound very confident now the MSA will come in weeks. Well what has, what has changed to give you that sort of confidence that it will definitely be in the next few weeks?

Gareth Davis - Chief Executive Officer

I think it's fair to say that obviously we’ve been dealing with the NAGS, as it were, National Association of Attorneys Generals, and obviously they… that’s a good one, I'll remember that one for the future… but also some of the individual settling states and the progress has gone pretty well. But, I think it’s probably for the MSA, we are probably the most complex CICA, as it were, of registration given that we are foreign company, obviously quite a complex structure. This all has to be gone through with the NAGS and the individual settling states. We've got a very good working relationship with them, we have made very significant progress and I think we are very close now to, to put in that one to bed. So, I think based on the evidence we have today with the settling states, and as I say the Attorney General in general, based on that relationship gives us that optimism.

Unidentified Analyst

And also, sorry, could I comment as well. Just to clarify one other point. You were talking about the £50 million and Gareth spoke about things you were doing. You were talking there about the brand side but in an earlier comment, you actually commented on some of the manufacturing savings that were coming through. So, we've got those too, if you'd like to come up to the £50 million, help it with the £50 million, so a mix up of those is, I think unpaid [ph].

Gareth Davis - Chief Executive Officer

I think…

Unidentified Company Representative

We need that £50 million includes the cost savings.

Unidentified Analyst

I am saying that, what we are saying is… Gareth said one wasn’t material, we didn’t take any significant cost savings into, and then, but we are seeing the start of things and so we are, we are confident of the £50 million as where we are at the moment.

Unidentified Analyst

And also, I am sorry Philip Morris International claimed that their market share was somewhat depressed in Germany in the Q3 period, because one of their major competitors was sort of major trade load in that quarter. Has your market share depressed in Germany for the similar reasons?

Gareth Davis - Chief Executive Officer

I think our market share in, in Germany was pretty much the norm, really. I mean we saw some growth in JPS and some further decline in West. So it’s relatively a stable situation for us other than new launches like Route 66, where there was obviously deliveries starting to be made, but I don’t think there was a anything abnormal at all about the situation, so.

There was couple more on that row, I don’t know, I am sorry, I’ll come to you in a minute. John, were you among them, okay, all right. Sorry, sorry Erik.

Erik Bloomquist – JP Morgan

Hi, Erik Bloomquist, JP Morgan. A question on Rest of the World, terrific growth this year. But I am wondering with the increase in taxes we are expecting, what that means in terms of both the growth, profits and the margins levels in key markets like Poland?

Gareth Davis - Chief Executive Officer

I think Erik if you, if you look historically at situations in the tobacco industry where there has been, and where there continues to be a regular sensible increase in excise, it tends to be quickly followed by a regular sensible increase in manufacturers' price increases. One tends to find that margins grow in those jurisdictions. So I think, going forward, from what I see and if you were to take developing markets, as prices increase, I think margins will increase and the other effect is the down-trading dynamic starts to kick in. So the positives we see there is obviously from our points of view we have a good clutch of economy and value brands which do very well on the back of down-trading and of course the roll-your-own and make-your-own situation. I think Central Europe is a classic model this last year, where it took a certain level, a certain tax and price level, for roll-your-own and make-your-own segments to actually kick into life. And it’s done that with a vengeance over the last 12 months and we have taken very significant advantage of that into with some huge shares now in the roll-your-own segments and make-your-own segments of those markets. And that will continue. I think that model is self perpetuating.

Erik Bloomquist – JP Morgan

And then the second question on the United States. Did Imperial take a price increase in September along with the other major manufacturers, Commonwealth?

Gareth Davis - Chief Executive Officer

Sorry. I think it was actually ineffective, it was reduced discounts, the price increase

Erik Bloomquist – JP Morgan

The price increase.

Gareth Davis - Chief Executive Officer

Yes. And there was one more on the second row and then I will move to the other, sorry.

Unidentified Analyst

Thanks. Bruce Davidson, Luall [ph]. Question on Davidoff, you indicated that profits had increased by 13%. I wonder if you would like to tell us what that number actually amounts to millions of pounds. But equally or perhaps more importantly, what has driven increase in profitability of that brand and where are the most important markets for it?

Gareth Davis - Chief Executive Officer

Okay, we don’t break the profits out by individual brands. So I am afraid the answer to the first question is no.

What have we done? I think two things really. One is, we have increased the number of variants. You may well have seen around Davidoff Black and White which is at a premium price, to Davidoff Premium Line, tends to be the most expensive cigarette wherever it is. We have also introduced Davidoff Rich Blue, and significant investment in Davidoff Slimline. So that’s from the portfolio side of it.

And then of course is the geographic expansion. Going into more new markets, I picked out Canada, Mexico, but there are several more in Africa and in Eastern and Central Europe, where we have pushed Davidoff harder and, not least of which is Turkey, where we saw a 32% increase in Davidoff volumes. So overall, it’s been very successful. And I suppose it's that positive upward mix towards Davidoff Black and White, and going into these countries has produced that increase in profitability. I think the positive thing, I would say, I think as we see so much more to go for in Davidoff, we really do think it’s got huge potential.

Unidentified Analyst

Thank you. And just one sort of picky thing on the tax payment. This year it's just about equivalent to the tax provided. Is that likely to be the pattern?

Robert Dyrbus - Finance Director

Well, over the long term, the short answer is yes. I think that you have gotten… but I mean you do constantly… with tax, it’s a question of when payments fall due, and also at various times you are always talking to tax authorities and you're going back years and payments come in and go out. But it should broadly equate it to the tax charge, maybe lagging it very slightly depending on which jurisdiction you happen to be growing in.

Gareth Davis - Chief Executive Officer

Adam. You don’t need a microphone.

Adam Spielman - Citigroup

Hi. Thank you very much. Couple of questions just following up on some of the other ones we have had before. First of all, in the US, can you talk about what your pro forma organic performance would have been like. So if you think about in dollars, and you said you are gaining market share but actually volumes are declining. There’s been a nice price increase.

Gareth Davis - Chief Executive Officer

I mean, marginal, not much. I mean, the market declined about 3.5% and the Commonwealth volume declined about 3%. So, slightly better than the markets performance.

Adam Spielman - Citigroup

And my guess is you have got a little bit of mix, but you have got the price. Does that end up with organic sales growth or an organic--?

Robert Dyrbus - Finance Director

I'm sorry, Adam, when you are talking about organic, you are talking about Commonwealth…

Adam Spielman - Citigroup

Commonwealth.

Robert Dyrbus - Finance Director

Rather than… we are saying, we have the papers and tubes business...

Adam Spielman - Citigroup

Yes. Yes. I got that point.

Robert Dyrbus - Finance Director

But I think, I would have… gosh, short answer is I don’t know but it was about 11% up into half year on an organic basis. So I think that would have been profit growth…

Gareth Davis - Chief Executive Officer

It was about 10% profit growth. Mostly.

Adam Spielman - Citigroup

And the other question coming back to the change in competition, you've said the pricing is better in Western Europe. My understanding is that it’s a lot better in Central and Eastern Europe, if you could just comment on that, and confirm that. And equally, how the situation in the U.K. looks with a new competitor? My understanding is that sequentially you are perhaps losing market share fractionally at the moment but maybe my base is wrong.

Gareth Davis - Chief Executive Officer

I think we start with the U.K. in terms of… when you say sequentially losing market sharer, you mean one month is up, one month is down.

Adam Spielman - Citigroup

Yes I mean if you look at the year, my understanding is nice market share gains are going to be slightly fractionally rolling over towards the end?

Gareth Davis - Chief Executive Officer

I would say May, June, July we lost a wee bit, and then we gained it back in August and September. So the latest plus, I mean, growing again to round about 46.5% mark in terms of share. So we don’t see a lot of change there. Obviously we got the fastest grower with Windsor Blue as well. I don’t think we are seeing any what I would call, significant change in the competitive climate in the U.K. market. We do… obviously BAT introducing Pall Mall in the market, Callahan [ph] and other new, but we haven’t seen you know anything I would say to cause any great concerns about say any great shifts in the competitive position in the U.K.

I think if one looks at Central Europe, I think Ritchie Gutler [ph], the Director of centrals Europe's here, I think fair to say, it’s bits and pieces in the sense that Poland, I think is a lot more positive than it was, should be a hugely profitable market, is at least getting profitable now. Czechoslovakia I think we have seen improvements and indeed in Hungary.

So obviously, it’s been some years in coming. We have been bemoaning the situation in Central Europe for a couple of years, it's very pleasing to see that things are looking on the upside there now starting to resemble normal rational markets. And you can see that carrying on over the next couple of years.

Adam Spielman - Citigroup

Ukraine and Russia?

Gareth Davis - Chief Executive Officer

Well in Ukraine we are certainly seeing, we are seeing a lot of what I would call very deep discounts, brands of the bottom withdrawn. That has happened in the last six or seven months. So the profitability of the Ukrainian market is improving.

I think in Russia, I think it depends on what your portfolio is like. We've held our share in Russia. We have invested quite a lot of money in brands in Russia this year. So we have actually put back more into it than we have taken out, as it were. I think there is general up-trading but we still have a situation where I would say, Russian margins still in the main, don’t even approach African margins. So still a long, long way to go in Russia on margins to get to what we would look for by international standards. But it’s going in the right direction.

Adam Spielman - Citigroup

Thank you.

Gareth Davis - Chief Executive Officer

Any more?

Jonathan Fell - Deutsche Bank

Hi, it's Jon Fell from Deutsche Bank. In the market we haven’t talked much about yet for pricing given it's improving in most other Western European countries as is Germany. Can you talk a little bit about how you see things developing there. I think I am right in saying, was there a big pack price increase in sort of October?

Gareth Davis - Chief Executive Officer

Yes. I suppose it's what the experts call technical price increase. In the big box 24s, the price was increased by 10 cents per pack, and that was in, Ritchie, correct me, was that June? Sorry it's effective, it's starting now, yes. But it was announced in June. So that’s taken place. And also one of our competitors I think has just announced price increase on a 100 millimeter.

So what we are seeing at the moment in Germany is what I would call segemental increase, rather than general market increase, I think it's fair to say.

Iain Napier - Chairman

Having said that, big box 24s is about 30% of the market in terms of volume.

Gareth Davis - Chief Executive Officer

So it’s a sizeable, and welcome effect.

Jonathan Fell - Deutsche Bank

And just a quick question on the cost of funding, Bob, I think in the statement or the well the presentation you said, your all-in average costs of debt's gone up about 5.5% and 5.4%. Are we still all right to be sticking 5.4%, 5.5% in the next year after Atladis is done as well?

Robert Dyrbus - Finance Director

Yes. I think in terms of our cost of funding, I would say that’s a reasonable assumption, assuming that we don’t see base rate go up through the roof. So 5.5% is still, I would say a reasonable cost of funding, for the group, going forward.

Jonathan Fell - Deutsche Bank

Thanks.

Gareth Davis - Chief Executive Officer

Okay any more?

Unidentified Analyst

Robin Smith [ph] with JP Morgan. Just two questions again on Germany. First, the decline in the share of private label, has that gone the way you thought it would? Has it taken… is it slower than you thought it was? And then just a general question about profitability, where are profits going to go now for this business? Obviously you have seen a big slump in profits. Do we see rapid recovery or is it going to be a long haul, two or three or four years to get back up to the level you saw last year, just a general overview.

Gareth Davis - Chief Executive Officer

The situation, first of all, I mean, private label is, I mean what we saw during the year was a share of around 13.5%, and I think ended the year right about 12.5%. So coming down, one would say. I think for part of the year, that’s somewhat of an advantage because they were actually late, slower, not by accident, no doubt planned, but their take up of the last price increase was quite slow. I think it's fair to say that about a five months advantage on the shelf prices, and so they gained a bit of share back in that period. And then since the price increase was taken, the shares had come back to 12.5% and trending downwards. In fact I think the spot share in September was round about 11.5%, if my memory serves me right. Obviously some of them are only, some of them only sell private label like Albie Sud and Label [ph] et cetera. So did you want to want to add something?

Robert Dyrbus - Finance Director

There was a benefit, and obviously we saw, if you likely, the decline rate, it was effectively flat and then over some of the months almost grew a little because of the transitioning from Singles, because Singles smoker is very into cigarette, we are obviously going into the value end of Singles and private label. So if you like and I think what we are now seeing is, if you like, the previous trend lines starting to reassert itself

Gareth Davis - Chief Executive Officer

And in terms of profitability, in Germany I think from now I think with the migration of Singles just about flush through. I think we have seen the worst of the issues in Germany. I think things start to get better. I don’t see it as… unless there is a general price increase, manufacturers' price increase, I don’t see the sort of six months from one year return to the previous profitable heights that we had. We are probably looking at a more of a two year gain to get back to that. But I do see it within, one defines the short term as a couple of years, getting back to at least previous levels. And with the cost based optimized, then really I think, more upside for Germany now than downside going forward. Hopefully the governments can help get control of this cross-border flow. There are some encouraging signs that the rate of increase is slowing quite markedly now. So if we can start to attack that 22% base, then obviously there's still a hell of a lot of people in Germany smoking. So there's a lot of potential there for the manufacturers to gain share and volume.

Elise Badoy - Goldman Sachs

Elise Badoy from Goldman. Just a follow-up question. On Lohista [ph], from the January expected date that you have given us for completion, what’s the timetable for Lohista, when do you have to make a decision?

Robert Dyrbus - Finance Director

Basically from completion there is a three month window, so by the end of that three month period, we either need to have made a tender offer or sold down to under 30%.

Elise Badoy - Goldman Sachs

Okay, thanks.

Unidentified Analyst

I just have a very quick follow-up, in Belgium the pictures you mentioned is being rolled out. Can you just talk about any trend changes, I mean it seems to me that it doesn’t seem to impact, but is that what you see, or is there something untoward happening to the introduction of the pictures?

Gareth Davis - Chief Executive Officer

As far has we have seen so far, the same conclusion as we have had, the pictorial seems to have more effect on non-smokers than smokers. And what’s new is that some of these regulations, I think the situation as we have seen in Canada, Singapore, Brazil where pictorial health warnings have come in and they have had little or no effect that we can see.

Unidentified Analyst

And cost increment about what you expected there as well?

Gareth Davis - Chief Executive Officer

Yes. In fact, it's probably a little bit better than we thought as we have had the time and obviously if one looked at then scale, it’s probably a little bit better than the now original worst fears. So the cost of manufacturing I think I'd say, they've come in a little bit lower.

Unidentified Analyst

Yes, hi. Two questions. One on the rest of Europe, I mean profits there have been relatively sort of stable for the last few years. You are gaining shares in cigarettes, but travel retail and fine cuts are going down. When does that sort of play out, when does the trade opportunity of what’s going up, what’s going down play out, so that you can start to get company average profit growth out of rest of Europe?

Gareth Davis - Chief Executive Officer

Well that’s a good question. And I think I am going to take a… there’s a little speculation in my answer, I suppose. But if one looks at the situation, the great variable in this is travel retail, which can be quite volatile, and certainly we have seen the last couple of years travel retail sort of coming down. I think we are probably at a situation now where we have reached, where we are going to reach on that situation. Probably fine cut, got a little bit more to go, and less in travel retail or reduction in travel retail. But in the next couple of years I'd see it sort of, coming to some sort of equilibrium in that situation. Obviously going forward, with Altadis absorbed it et cetera, the visibility becomes a little more difficult on that. But I think over the next couple of years, we will see that travel retail effect sort of reaching that equilibrium. And then I think we will start to get a clearer position.

If we look at the overall cigarette volume growth in the rest of Western Europe, it was very good and the underlying profit growth in the rest of Western Europe on cigarette was about 8%. So it’s looking quite good, apart from these fluctuations caused by travel retail. I think the underlying performance within the market is very sound.

Robert Dyrbus - Finance Director

And there was a bit of a drag this year as well because of the euro affecting the terms of the, some of the product brickbats [ph] for example, the sterling input and Euro sales. So of the £5 million I talked about effectively there was a £7 million

revenue impact £5 million profit impact, in terms of the rest of Western Europe.

Unidentified Analyst

And the other question’s on cash conversion. Even adjusting for the stock bill it’s a bit down from previous levels

Robert Dyrbus - Finance Director

Well, yes, it is. Basically it’s I think it was 81%. If you have seen, and I would have seen working capital would be flat so that £194 million would take the conversion rate to about 94%. It's still a few million short, but again, we were talking about significant investment, not total investment. But we are talking about investment of some £20 million in terms of equipment in Central and Eastern, well Eastern Europe, sorry, to expand capacity there. We put a primary into Volgograd and some new machinery into both Volgograd and Kiev in terms of expansion behind that. We put some new style, machines for some new styles, things like Slims and Superslims. Again if we can’t, if we don’t have the kit to make them, we have to invest. And we had £14 million on the Taiwanese factory. So in those three you have got what, £40 million, £50 million. So if you just add those two together, that’s a 100%, in fact a little better than 100% cash conversion.

So it’s there or thereabouts. It’s a nice problem to have in terms of, if we are increasing volume, we do need certain new kits. The good thing about it is, one machine fully loaded will pay you back for something less in the year, in terms of the amount of profit it generates. So I suppose you could call it a consumable if it were stationary company.

Unidentified Analyst

So do you expect cash conversion of a 100%?

Robert Dyrbus - Finance Director

Next year I would expect more than a 100% because of course £194 million pounds will come back. So the £194 million is there at this year end and absent…

Gareth Davis - Chief Executive Officer

Assuming this is the last year of loading. And, I think we have potentially got to you because of the derogation of [inaudible].

Robert Dyrbus - Finance Director

Some of them would be there, just depends on the…

Gareth Davis - Chief Executive Officer

We would hope that loading stops over. We'd love to see the end of it.

Okay. Ladies and gentlemen, if there are no more questions, thank you very much for joining us.

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Source: Imperial Tobacco Group PLC FY07 Preliminary Earnings Call
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